Bond Expert Thursday Outlook: The Fed Effect

Includes: BIV, SPTL
by: John Jansen

Prices of Treasury coupon securities are posting strange and mixed results in overnight trading. It appears that for the most part the market is taking a bit of a respite following the landmark move which the Bernanke Fed inspired with its made in the USA version of Quantitative Ease (QE).

The yield on the 2 year note has increased by 4 basis points to 0.85 percent. The yield on the 3 year note climbed 2 basis points to 1.17 percent. The yield on the 5 year note is unchanged at 1.57 percent. The yield on the 10 year note edged lower by 2 basis points to 2.52 percent. The yield on the 30 year bond edged higher by 2 basis points to 3.55 percent.

The 2 year/10 year spread narrowed to 167 basis points. In my opening piece yesterday that spread was 200 basis points.

The 2 year/5 year/30 year spread is currently 123 basis points. When I wrote my opening piece yesterday that spread was 90 basis points. At that level it was at the expensive end of the recent range. At one point in the frenzied trading yesterday I clocked it at 132 basis points.

That move represents a huge demand for the 5 year note relative to the 2 year and the 30 year. The demand stretches to the 10 year note also. The 2 year/10 year/30 year butterfly has moved 50 basis points in favor of the 10 year.

Some of the move reflects the FOMC notice that (to the detriment of the Long Bond) it will concentrate its efforts on the 2 year through 10 year portion of the yield curve. I think it also anticipates a wave of refi activity as the Fed’s purchases of mortgages should drive mortgage rates lower and encourage refi activity.

As I have noted ad nauseam, the Treasury will announce some supply today. 'Some' is the wrong adjective as the sum will be nearly $100 billion in coupon issuance. Look for about $40 billion 2 year notes, $34 billion 5 year notes and $22 billion 7 year notes.

There is also some meaningful economic data on tap. The weekly jobless claims data should hover around 655K and the Philadelphia Fed Manufacturing Survey should post a small decline from the -41 of last month.

IG 11 is opening 1 1/2 tighter at 226/227.5.

  • CDS on large banks are also tighter:
  • JPM 5 tighter
  • WFC 5 tighter
  • C 15 tighter
  • BAC 10 tighter

MBS: Mortgages are opening 8 basis points to 9 basis points tighter to the 5 year Treasury with swaps unchanged.

Originators should be substantial sellers once the market settles down and, absent the Fed, those sales will cheapen the market.

Domestic banks are better sellers.

Japanese accounts have been hibernating into year end.

Non -Japan Asia has been and remains a buyer of GNMA paper.

Treasury Update (9:30AM ET)

Benchmark Treasury bond yields continue to decline after a round of equivocation overnight.

On balance,dealers report much better buying from an eclectic group of investors.

Fast money types and central banks have been chunky buyers in the 5 year through 7 year region. There has been better buying in the long end by a diverse group of players.

The only sector in which I have encountered talk of better selling is in the 2 year sector where traders tell me that banks have been selling.

Off the run bonds are improving significantly. The 8 1/2s of Feb 2020 have outperformed the 10 year by 9 basis points. The Nov 2024s have bested the bond by 4 basis points. The 9s November 2018 have outperformed the 10 year by 12 basis points.